A measure passed by the House tonight, which would permit the US to impose tariffs on countries that keep their currencies artificially low, is at this juncture a mere statement of intent. It is nevertheless playing into a dynamic of the hardening of stances between the US and China.
Note that the bill has yet to pass the Senate, but given its wide approval margin, and more important, broad bipartisan support, a win there seems assured. But the bill does not require action, and so leaves any escalation in the hands of the executive branch. Given Obama’s tendency to talk tough and do little beyond elaborate symbolism, such as misbranded reform measures, I would not expect the Administration to suddenly change stripes and increase pressure on China in a meaningful fashion. Not surprisingly, China pointedly lowered the value of the renminbi today, clearly signaling it has no intention of cooperating.
Nevertheless, the move elicited predictable verbal fireworks from the Chinese officialdom. China denied that it undervalues the renminbi, which can hardly be accepted at face value. Not only is the renminbi undervalued 25% by some recent estimates, but the continued purchase of dollar assets is prima facie evidence of continued currency manipulation. Tim Duy has also pointed out that China’s purchases of the yen, which are clearly destructive to Japan, is tantamount to laundering dollar purchases (China buys yen, Japan has to buy more dollars to drive the yen back down). Indeed, Premier Wen Jinbao ‘fessed up that letting the renminbi rise would put a lot of domestic manufacturers out of business. So China clearly has motive for keeping the renminbi low, and it is by his admission to keep otherwise uncompetitive firms afloat.
China also charged the legislation would violate WTO rules, which is narrowly correct if the US does not first certify China as a currency manipulator. But if the US imposed tariffs withing the WTO framework, the impact would be limited due to the cumbersome nature of the countervailing duty process (companies have to prove they are being damaged by directly competing imports).
The measure is thus more important as a negotiating tactic than for any immediate impact. Congress has signaled loud and clear that it wants to see some movement from China. Given the wide margin of the vote, if China does not make some concessions and US unemployment and trade deficits remain high, Congress is likely to vote in legislation that has more real clout. The rhetoric was heated. Per the Financial Times:
“If China wants a strong trading relationship with the United States, it must play by the rules,” Nancy Pelosi, Democratic speaker of House, said ahead of the vote on Wednesday.
Some of the rhetoric was even stronger. “They cheat to steal our jobs,” said Mike Rogers, a Republican from Michigan, while Dana Rohrabacher, a Republican from California, attacked China’s “clique of gangsters” that was doing “great damage to the people of the United States of America”.
With the US having plenty of resources slack, this is one of the few times that orthodox economists would endorse trade restrictions. Normally, domestic considerations would be offset by the desire of US corporations to maintain access to China’s market, but the China has also recently become a less friendly venue for foreign players.
The problem, however, is China has taken to being non-negotiable, and is usually a very effective posture, but it runs the risk of driving other parties away from the bargaining table entirely. China has been reinforced in this behavior because its past shows of pique have led to quick climbdowns. It has occasionally used headfake concessions like its pretense that it would let the renminbi move to a more market based price, to keep its trade partners a bit off balance.
But China has made two very large errors. Despite playing a strong tactical game up to now, it has made a fundamental strategic mistake. It appears to have no plan to change from a mercantilist model. It somehow honestly seems to think that if it can avoid what happened to Japan , ie being forced to revalue its currency (per the 1985 Plaza accord), all will be well. It actually has been moving to a LOWER consumption share of GDP post crisis, the reverse of what you’d see if it were trying to rebalance the economy.
Everyone understands that for China move to a more consumption-driven economy is a very long term project. China could get away with a ton of foot dragging if it were taking legitimate steps in that direction, as it needs to. So far, however, it has demonstrated no commitment to that effort, so it is effectively exporting goods and related unemployment to other countries. In a period where everyone expects protracted low growth, when there is already a large overhang of unemployed workers, that will not wash. Other countries start retaliating on the trade front. And China, with a severely imbalanced economy, with 50% of GDP coming from exports and increasingly unproductive investment (it now takes $7 of investment to generate $1 of GDP growth, a stunningly bad ratio for a developing economy, and markedly lower than the tradeoff in the US), is much less solid that it looks.
China’s second error is a recent switch to disproportionate retaliation. This may simply be a variation in tactics, and it may revert to more measured responses. But if this becomes its new modus operandi, it is likely to backfire and result in isolation, as it has with Israel. The recent incident involving an arrest by Japan the captain of a trawler operating in disputed waters provides an example. From the Financial Times:
The immediate cause of alarm is Beijing’s rough-house tactics following the captain’s arrest in waters near the disputed Senkaku islands, known as Diaoyu islands in Chinese. Not only did Beijing insist on the captain’s immediate release, a demand to which Tokyo eventually capitulated. It also escalated the dispute. It arrested four Japanese nationals; blocked exports of rare earths used by Japanese electronics companies; cancelled diplomatic exchanges; and allowed anti-Japanese demonstrators to pour on to Chinese streets. (It even canned the tour of SMAP, a Japanese boy-band.) Even the release of the captain did not mollify Beijing, which demanded an apology and compensation.
The Japanese have a saying: teki no teki wa mikata, which means “enemy of enemy is friend.” As much as America has done a great deal to make itself unpopular around the world, China’s muscle flexing is making US look attractive by comparison, no mean feat. China is not yet secure enough in its footing to afford the consequences of uniting much of the world against it. But if it continues on a belligerent path, it may do precisely that.